Foreign Investment in China

China WFOE lawyerIf you are an American company doing business in China, you don’t need me to tell you how so many things have changed for you over the last year or so, and so I won’t.

But I do need to tell you — somewhat urgently — that if you are operating in China without a legal Chinese entity, you need to stop. Like right now.

Back in March, we did a post, Doing Business in China with Deportation or Worse Hanging Over Your Head in which we discussed how “China has like never before been tracking down foreign companies (especially U.S. companies) that are operating in China without having a business entity (a WFOE or a Joint Venture) that allows them to legally do so. See also Donald Trump and Your China Business: Double Down, Ditch It or Die and Donald Trump and Your China Business: Double Down, Ditch It or Die, Part 2. Our thesis — based on what we were seeing on the WFOE front and on other crackdowns involving even things like bar fightsvisasexpat taxescannabis, and employment law — was that China was toughening up enforcement against foreigners and foreign companies in China on all fronts, but especially against Americans and American companies as a sort of a slow and not terribly public retaliation against President Trump.

With all the talk now about US tariffs against China, legal enforcement in China against American companies operating in China without a WFOE has gone into hyperdrive. One of our readers, herself a China lawyer, recently wrote me to let me know how ridiculous she thought I was for believing Beijing would “quietly” go after American companies. My response to her was that we had no idea whether China’s stepped up legal enforcement is being directed from Beijing or is more in the nature of a slow and quiet and yet widespread uprising against the United States being mounted by government officials throughout China.

We can debate who is leading this enforcement charge and even the reasons for it, but to me the most important thing is that if you are an American company and you are not in full compliance with Chinese law you are at greater risk now than you have ever been. If you are doing business in China, especially if you are doing business there “through” a Chinese citizen you are paying, you need to think long and hard about your China company formation options.

Whenever we write about how China is getting tougher with such and such a law, we invariably get emails and/or comments saying how idiotic and/or unfair we are for criticizing China for enforcing its laws. Just so the record is clear, we have not said that and we are not saying that; we are as neutrally as possible merely writing on what we are seeing and we would be more than happy to leave it to the legal philosophers to put these sort of real-life China business and legal issues into some larger context.

In addition to the stepped up enforcement of China’s WFOE requirements, we are also seeing a massive uptick in American companies forming Hong Kong Companies or consulting WFOEs in ill-advised efforts to get legal. So let me use this blog post to once again make clear, forming a company in Hong Kong does not do a thing to make your business operations legal in Mainland China:

Nor will forming a company in Macau or Taiwan or Singapore. If you are doing business in the PRC/Mainland China, you need a PRC legal entity, such as a WFOE or a Joint Venture. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China. See also A Hong Kong Company Is NOT a Mainland China Company and a Hong Kong Trademark is NOT a Mainland China Trademark. If it were otherwise, virtually nobody would go through the agony and the costs of forming a WFOE; they would instead pay some accountant in Hong Kong about USD$1,000 and have an HK company in less than a week. Please, please, please do not fool yourself into believing otherwise!

In fact, the more you get on the grid in China without actually doing everything the right way in China, the more you make your illegality more obvious and easier to spot. See Quasi-Legal In China. Not the Place You Want to Be andQuasi-Legal in China. Not the Place You Want to Be, Part II.

We are also hearing from many American (and some European companies as well, but we’ll save that for a subsequent post) companies that formed their WFOE in China the “fast and easy way.” Some less than reputable WFOE formation companies will tout how they can form China WFOEs quickly and cheaply and for only around USD $15,000 in minimum capital. What these WFOE formation companies typically then do is form your company as a consulting WFOE in an “easy” China city. Please don’t fall for this. If your WFOE is not going to be in the consulting business, it cannot legally operate as a WFOE in China and it will get shut down. See How To Form a China WFOE. Scope Really Really Matters, Part II. And if your WFOE is going to be operating in Xi’an you do not want it to be formed in Shenzhen, for just a whole host of reasons.

If you are not complying with Chinese laws it is important you move quickly to get into compliance. But it is also important that in moving quickly you not expose yourself to even more and potentially greater problems. To borrow from a famous legal quote, you should move to get legal in China with all deliberate speed.

China company formation done wrong is not going to be your answer.

What are you seeing out there?

China technology IPThe standard story is that the Chinese government has decided to “corner” the world market for electric vehicles. The most expensive and important component for an electric vehicle (“EV”) is the battery pack. So the the logic goes that the first step in this plan is for Chinese companies to dominate production of EV batteries.

The recent Shenzhen stock exchange IPO of Ningde, Fujian based Contemporary Amperex Technology Ltd (CATL) has been seen as a key phase of this process. According to the press reports, CATL raised USD $830 million in its IPO completed on June 10. Though far less than the $2.0 billion CATL had originally planned to raise, this is nonetheless a substantial sum.

CATL plans to use the proceeds from its IPO to buildd new production capacity for 24Gwh of batteries focused on the EV market. CATL plans for its Ningde facility to become the largest EV battery maker in the world, with a final projected capacity of 50 Gwh scheduled to come on line by 2020. This can be compared with the Tesla Nevada Gigafactory 1 which is projected for 34Gwh capacity.

Though this is a considerable achievement for a company located in the isolated country town of Ningde, its significance is not as reported. The real issue here is not the Chinese government’s decision to promote high volume manufacturing of a basic industrial product. The issue is rather with the technology behind the product and the control of that technology. Production within China may become controlled by Chinese owned companies, just the way so many other basic industrial commodities are under such control today. But it is unlikely China will develop new EV technology through indigenous innovation. That is where the real challenge rests.

Consider the basic issues:

  1. CATL’s advantage rests almost entirely on China’s preferential policies. First, the Chinese government is providing substantial subsidies to EVs for domestic transport. Second, the Chinese government has set the rules so that only EVs using product from Chinese battery makers (CATL and BYD) qualify for these subsidies. This is not a market phenomenon, it is simply an artifact of Chinese government subsidies. This means CATL is entirely dependent on the subsidy program. If the subsidies end, the CATL market advantage disappears
  2. Production of EV batteries in China is largely irrelevant to U.S. EV manufacturers. Batteries are heavy and dangerous and so battery manufacturers seek to locate as close to vehicle manufacturers as possible because long distance shipping is not practical. China is currently the largest market in the world for EVs so the big battery manufacturers are moving as much production capacity to China as possible. Panasonic, LG Chem and Samsung are major players that have invested heavily in China production. Even Tesla has announced plans for a battery gigafactory in China. But the key is that the production for those factories is limited to China EVs. Regardless of the capacity built in China, it will have little impact on the market for EV batteries in the United States or in Europe.
  3. What CATL is doing is just old fashioned Chinese industrial policy. It is manufacturing a product that has mostly become a commodity. Its strategy is to make an “adequate” product in high volume, competing almost solely on price. In 2017, CATL reduced its product price by 30%. As it expands production, further price reductions are expected. Usually this policy leads to overproduction and value/market destruction and this could happen in China as CATL and BYD and others engage in a race to the bottom. However, unlike what Chinese industry has done in steel and electronics, this race to the bottom will not have a major impact on world markets because the product cannot be readily exported. The situation is more like that of cement in China: the destructive industrial policy has no impact on the rest of the world because the product cannot be exported.

The real issue here is that CATL is investing huge sums in manufacturing a product with a less than rosy future. CATL makes old generation versions of lithium cobalt oxide batteries. Though lithium is readily available, cobalt is rare and expensive. More importantly, it is well known in the EV world that lithium cobalt batteries do not have the energy density to compete with petroleum based engine systems and other battery types are already being developed to replace lithium cobalt. Though lithium remains a constant, other metals such as manganese, nickel and even iron are being developed as alternatives to cobalt.

Though CATL appears to have a large R&D department, it does not seem to engage in its own cutting edge research related to developing the new generation of EV batteries. R&D for CATL is confined to two areas: a) additional cost cutting and b) assimilating existing battery technology developed outside China. As CATL continues cutting its prices, its ability to do cutting edge research and development will likely be further constrained.

So what’s the real take away here? CATL and other Chinese EV battery makers do not need help on the investment and production side. They have that covered. But they need access to evolving battery technologies to achieve increased energy density, reduced material costs, reduced weight and increased safety. In other words, we should expect them to fall back on another standard Chinese industrial policy strategy: assimilation of foreign developed technology.

What I expect to see in the next decade of electric vehicles in China is an avid interest in foreign technology in all related fields, centering on power supply (batteries/rechargers) and on vehicle technology. Chinese companies will use all the standard techniques that we have discussed on this blog to try to acquire foreign technologies that are already rampant in the auto tech and other high tech industries: The question is not so much what the Chinese companies will attempt to achieve; the question is whether foreign developers of these critical technologies will give them away or demand adequate compensation.

For more on the “giving away” intellectual property to China versus getting adequately compensated for it, check out the following:

And for more on China IP issues directly related to the automative industry, check out China IP Challenges for Automotive Suppliers.

China WFOEOur China lawyers are constantly helping foreign companies set up companies in China — usually wholly foreign owned enterprises or WFOEs. When a client’s WFOE is approved or a freshly minted WFOE gets in touch with us requesting guidance on China’s employment law, we usually send out the following WFOE Employment Letter:

Now that your WFOE is up and running, our China employment lawyers will assist you in making sure your WFOE is protected on the employment front. Towards that end, the first thing we will do is provide you with employee agreements for your use with all your China employees as part of what we call our Initial Employment Package, which consists of the following for each employee:

  1. An Employment Contract;
  2. A set of Employer Rules and Regulations;
  3. A Trade Secrecy and IP Protection Agreement; and
  4. A Sign Off Agreement (acknowledging each employee’s receipt of the Employer Rules and Regulations).

Having the above for your employees is crucial to operating as a WFOE in China with employees. In addition to the above mandatory documents, we also draft the following optional agreements for eligible employees:

  1. Non-compete Agreement; and/or
  2. Education/training Reimbursement Agreement.

During the process of drafting the Initial Employment Package, we will also work with you on any additional employee-related procedures you might need in China. For example, a common employment law issue we see with new WFOEs (and sometimes established WFOEs as well) is related to employees who work under an alternate working hours system such as the Flexible Working Hours system. In most locales, an employee cannot be designated to work under such a system until its employer has obtained government approval for the WFOE, which usually requires we work closely with the local labor authorities.

After you approve the employment documents we create for you, we will let you know what you need to do to maintain those documents. Ideally, the WFOE’s legal representative would sign all employment documents with WFOE employees, and the second-best option would be for the WFOE’s general manager to sign.

It is important the WFOE affix its official chop on all relevant employment documents. Besides stamping the company seal on the documents, you can also fan out the pages and stamp your company seal across all pages to make them look even more formal.

You should also make sure all your employees sign and date the documents appropriately. It is best to have both parties (the WFOE and each employee) execute the documents on the same day, before or on the employee’s first day at the WFOE.

You should provide one copy of the fully executed employment documents to each employee for their own records and you should hold onto at least one original copy of each fully executed document. Most places in China require you retain the employment contract for a minimum of two years after an employee’s departure, but we generally advise you hold onto the originals of all employee-related documents for as long as possible.

Please let us know right away if you encounter any issues in the signing process.

We recommend you check in with us as around one year from now for an assessment of your China employee situation. This quick audit normally involves our reviewing your employment-related documents, checking for any possible non-compliance against all national and local employer laws, speaking with your HR people and/or management regarding any imminent or potential employee problems (this includes you thinking about terminating an employee) and resolving any employment matters. Spotting employee issues and taking appropriate actions early can significantly reduce your headaches and costs. China’s employee termination laws are extremely strict and your costs to make sure an employee termination is handled correctly will be considerably less than your costs to defend against a wrongful termination lawsuit.

We also recommend a subsequent employer audit about three years from now. Among other things, because most WFOE employees start with a three-year employment term it is advisable to spend some time considering whether to extend the employee’s contract before the initial employment term is up. Because terminating a China employee is generally so difficult, you want to be sure not to retain an employee for a second employment term unless you are certain you wish to continue employing that person. Failing to properly terminate (or otherwise renew) an employee before his or her initial term has expired may convert that employee to a lifetime employee who you must retain until he or she reaches the mandatory retirement age. If you use a shorter initial employment term for an employee, we suggest you come to us at least one month before that employee’s employment term expires.

China’s employment laws are complicated and localized and they can change quickly. You should therefore have your employment situation checked regularly to confirm you remain in compliance with all applicable employment laws. I mention the hyper local nature of employment laws because it is not uncommon for companies to get into trouble when they hire employees in a new locale in China without effective employee documents for that specific locale.

Please do not hesitate to contact us should you have any questions or concerns now or along the way.

China employment lawyersIn late 2017 an old and yet important set of China Employment laws —the Measures for Severance Payment due to Violation or Termination of Employment Contracts — issued by the then-Ministry of Labor back in 1995 was abolished by the PRC Ministry of Human Resources and Social Security. Since our China employment lawyers keep getting questions regarding the impact of this change I am writing this post to provide some clarification.

The short answer is that there are no significant changes. The fundamentals of China’s employment laws have not changed. China is still NOT an employment at will jurisdiction and its employment laws remain very local. 

The old Measures provided guidance on how to calculate statutory severance. They had some special rules for calculating severance payments, including (1) how a 12-month cap on severance would apply to mutual terminations or terminations for incompetence, (2) how severance was to be calculated using the average monthly wage for the 12 months prior to termination under “normal productions conditions,” and (3) how to calculate severance for employees terminated after various leaves of absence, for employees with contracts that can no longer be performed due to major changes surrounding execution of the employment contract, and for mass layoffs.

Before these Measures were abolished, many Chinese arbitrators and judges held that they had already been partially annulled because they conflicted with the China’s Employment Contract Law, but the legal outcomes on this issue were inconsistent.

When China’s Employment Contract Law took effect on January 1, 2008, it made clear that for terminated employment contracts severance payments under Article 46 of this Law shall be calculated based on the number of years of employment from the implementation date of this Law. The basic rule under the Employment Contract Law is that for each year (which is any period longer than 6 months) an employee has worked for the employer, he or she is entitled to one month’s wages in severance. For any period of employment of less than 6 months, the employee is entitled to half a month’s wages. If an employee’s monthly wage exceeds 300% of the local average monthly wage for the preceding year, the local average can be used to calculate the severance payment. In this situation, the number of years of service used to calculate statutory severance is capped at 12 years.

But the Employment Contract Law left open how to deal with an employee whose employment started before January 1, 2008. Before the mentioned Measures were annulled they were still technically in effect and this created several different methods for calculating severance. Subject to varying local employment laws, the specific method depended on: (1) the employee’s years of service with the particular employer; (2) how much time the employee put in working for the particular employer before January 1, 2008; (3) the employee’s average monthly wage during the 12 months before the employment contract ended or was terminated; and (4) the basis on which the employment relationship terminated or ended.

Not much has changed with the annulment of the Measures, though as is pretty much always the case with China’s employment laws, many of the specific changes (and lack of changes) will vary depending on the locale in which the employer is located.

Suppose the Measures were still effective and the employer’s locale does not have different local rules. An employee who worked for her employer since June 1, 1995 is terminated pursuant to a mutual termination agreement signed on January 1, 2018, According to China’s employment laws, the employee must receive severance. How do you calculate this employee’s severance if her average monthly wage during the 12 months prior to termination was greater than 300% of the local average monthly wage for the preceding year? If you apply the rules within the Measures, you would divide it into 2 periods in calculating the severance: (1) for the period before January 1, 2008, at her average monthly wage during the 12 months prior to the termination multiplied by 12 (because it would be subject to a 12-month cap); and (2) for the period after January 1, 2008, the severance would be 300% of the local average monthly wage for the preceding year multiplied by 10.

After annulment of these Measures the severance calculations under the above scenario do not change much. You still must divide it into 2 periods. Period one is the period before January 1, 2008 and her severance for that period would be calculated using her average monthly wage during the 12 months prior to her termination, multiplied by 13 (since the 12 month cap no longer applies); for period two, the period from January 1, 2008, her severance would be 300% of the local average monthly wage for the preceding year multiplied by 10. As you can see, in this scenario, the annulment of the Measures will increase the employee’s severance by 1 month at the average monthly wage during the 12 months prior to termination.

So at the end of the day, the most important factors for calculating severance payments are still how much the employee made during the 12 months prior to termination and when the employee started working for the employer. And of course, what your local employment rules say as well.

But whenever our China employment lawyers deal with China employment severance situations, our advise is usually not to get too bogged down with the severance amount because by far the most important thing is to make sure your termination is lawful. If you lack a legal basis (again, both under China’s national employment laws and under the local laws that apply to your specific business) for the termination there is little point in spending time calculating whether you have applied all the applicable severance caps.

And it is in the termination itself where our China employment lawyers most often see the big mistakes. Far too often foreign companies doing business in China terminate employees without a legal basis to do so. The easiest and safest way to terminate a China-based employee will almost always be via a mutual termination, using the minimum statutory severance as a starting point in your settlement discussions with your departing employee. When dealing with a mutual termination situation, paying the employee more than the minimum statutory severance does not invalidate the mutual termination agreement and doing so often makes sense as a way to secure a fast and relatively amicable resolution.

China AttorneysOne of the things my firm’s China lawyers are always saying and seeing is how China is constantly getting more legalistic, especially with foreign companies doing business in China. I used to believe this would lead foreign companies to become more careful, but this has not happened. Too many foreign companies — for all sorts of different reasons — remain far too nonchalant and increasing legalization only increases the likelihood this attitude will eventually harm them. In this series of posts (of which this is the first), I will write about the most common incidents our China attorneys see involving foreign companies that get into trouble in China for being careless or sloppy or just too trusting.

As for the title of this post, I have been studying Spanish for the last six months or so and oftentimes when I give a wrong answer my teacher will ask “¿Estás Seguro?” which means “are you sure?” I always respond by saying, “no, porque….” because I know she would not be asking this question if my answer were 100 percent accurate. I am asking the same question regarding China company formations because we far too often see instances where a foreign company believes one thing but the reality is something else entirely.

Forming a China company is a prime example of this, both with WFOEs and Joint Ventures. What usually causes the problem to bubble to the surface is different as between a WFOE and a Joint Venture, but what caused the problem in the first place is nearly always the same: the foreign company trusted without verifying.

The WFOE Problem. The WFOE problem is a somewhat simple one. The foreign company believes it has formed a WFOE in China (oftentimes long ago) and that it is now operating completely legally there. The foreign company typically then has a problem with its most important China “employee” and it wants to terminate that employee. The first thing our China employment lawyers usually do in this situation is to look at the official Chinese government corporate records for the WFO so as to get a better handle on the employee’s authority at the company. Sometimes we discover there is no WFOE.

At this point, the legal issue is no longer terminating an employee of a WFOE; it’s figuring out what makes sense in light of a messed-up China situation and a company’s present-day China goals. You cannot terminate an employee from a company that does not exist.

How does a company get to this point? What leads a company to believe it had a China WFOE when it didn’t? Ninety percent of the time the fatal mistake was trusting the person the company now wishes to terminate. That person claimed to have formed a WFOE for the foreign company but never did. Maybe he or she (though in my recollection it’s always been a he) formed a Chinese domestic corporation he owns. Or maybe this person never formed any Chinese entity at all. In any event, the foreign company  paid money to this person believing this money would be used to form a WFOE. Virtually always, the company then paid more money to this person believing this money would go to pay rent and personnel and taxes and other business expenses. Probably some of the money went to these things, but it is likely a good chunk of it went straight into the pockets of the person who lied about having formed the WFOE. Not sure why, the companies in this circumstance seem to be disproportionately Northern European. Just putting that out there.

The Joint Venture Problem. This is really two different problems. One, the non-existent Joint Venture, which is very similar to the WFOE problem, but usually a bit more complicated. The putative JV partner is put in charge of forming a China Joint Venture and it either does never forms any company at all or it forms a company in Hong Kong (or even in the United States, believe it or not!) that the foreign company believes to be a China Joint Venture. The foreign company thinks that the Hong Kong or US company owns a company in China and it thinks this corporate structure is itself a China Joint Venture. It isn’t and the China entity into which the foreign company ends up pouring time and money and technology is not in any respect owned by the foreign company. The foreign company then at some point becomes concerned about never having received any money from its Joint Venture and now the Joint Venture has gone completely silent and is not even responding to emails or the Joint Venture is now successfully competing directly with the foreign company. See China Scam Week, Part 6: The Fake Joint Venture.

Two, the foreign company trusted its Chinese Joint Venture partner and the lawyer its Chinese Joint Venture partner chose to prepare the necessary Joint Venture documents. Now there is a problem and those documents were written in such a way as to favor the Chinese side so completely there is nothing the foreign company can do to resolve it. See China Joint Ventures: The Tide is Out.

Do you have a Chinese company? ¿Estás Seguro?  Maybe you should double-check.

 

 

 

China Joint VenturesUnited States media has recently been frequently writing of how China forces foreign companies to relinquish their intellectual property to Chinese companies to be able to do business in China. This issue has been getting a ton of press lately because this is one of the justifications President Trump has been using to increase import tariffs on imports from China. It really isn’t this simple though. Many stories make it seem foreign companies must always relinquish their IP or at least must always do a joint venture to do business in China and doing a joint venture will mean losing your intellectual property.

Truth is that for most industries doing a joint venture is 100% voluntary on the part of the foreign party and truth also is that doing a joint venture need not include relinquishing your intellectual property. Much of the time foreign companies lose their IP to Chinese companies by falling prey to what the China lawyers in my firm call “the joint venture scam.” This scam is quite old — old enough for many Chinese companies to have thoroughly mastered it by now — and it usually works as follows:

  • The foreign company seeks to sell its complex and expensive technology to a Chinese company on a standard technology licensing basis.
  • After much discussion, the Chinese company asserts that the price is too high for an untested technology. The Chinese company then offers to establish a China joint venture company with the foreign company owning a percentage of the China Joint Venture.
  • The foreign company contributes its technical system in exchange for its ownership interest in the China Joint Venture and the China company contributes the rest. The IP contribution by the foreign company means the China JV now owns the technology for China. The China JV agrees to purchase more technology from the foreign company at full prices after the Joint Venture is up and running.
  • The foreign company then delivers and fully trains the Chinese side in how to operate the foreign company’s technology.
  • The China JV never purchases anything from the foreign company claiming that the foreign company’s technology does not work properly or as claimed. The foreign company eventually discovers that its technology has been cloned and is being used by a facially unrelated company in China. Since the China JV owns the technology, this unauthorized use probably infringes on the Joint Venture’s intellectual property rights, but so what? The JV must sue to defend its rights but because it is  controlled by the Chinese company its management refuses to take any legal action.
  • The JV then disappears, sometimes with the Chinese side buying out the foreign company at a substantial discount.

This system in various forms is still being actively used in China. And foreign companies still sometimes fall for it, but not you. Right?

For more on China Joint Ventures, check out China Joint Ventures, the 101.

China WFOE employment law
Get off on the right employment law foot when forming a China WFOE

Our China lawyers are constantly helping foreign companies set up companies in China — usually wholly foreign owned enterprises or WFOEs. As part of these WFOE formations, we help our clients with their employment matters that arise before, during and after the WFOE is formed. One of the things we always do for our WFOE formation clients is draft the employment documents they will need for their newly established WFOE.

When a WFOE is up and running, it needs employee agreements in place for all its employees. When we are called on to provide China employment law assistance to China WFOEs-to-be and freshly minted WFOEs, we usually recommend what we call an Initial Employment Package, which consists of the following for each employee:

  1. Employment Contracts
  2. Rules and Regulations
  3. Trade Secrecy and Intellectual Property Protection Agreements
  4. Sign Off Agreements, (acknowledging each employee’s receipt of the Rules and Regulations)

Having the above for your employees is crucial to operating as a WFOE in China with employees. If all you have is an employment contract, you are not fully protected. Specifically, your technical secrets or other trade secrets and the related intellectual property rights are not well protected as against your employees. And you likely will have no recourse against an errant employee no matter what the employee’s wrongdoing, since you do not have a set of China-centric Rules and Regulations to facilitate penalties or termination.

Your Rules and Regulations need to work for your specific locale(s), so if you have multiple locations in China, you need separate, standalone policies tailored for each location. Your employment contracts also should be localized. For more on the need to localize your China employment documents, see China Employment Law: Local and Not So Simple. We have worked with 1) companies with one WFOE and employees throughout China, 2) with companies with multiple WFOEs, one for each city, and 3) with WFOEs with branch offices in each city in which they have employees. Each of these structures require different documentation.

We also frequently draft non-compete agreements and these also virtually always need to be tailored to the specific situation, with that usually depending on the positions of the employees and their salaries and the shelf-life of the information that needs protecting.

Another common employment law issue we see with new WFOEs is what they can and should do with employees who work flexible hours. It is important to note that your new employees usually cannot be designated to work under China’s flexible working hours system until you have obtained the necessary government approval for the WFOE and it is up and running.

It pays to start with a strong employment law and document foundation for your China WFOE.

 

 

 

 

 

China employer audits China employment lawyers

As I have previously written, no (foreign) employer is too small for China’s regulators and in some respects the smaller you are, the more you need one. I say this because when a company with 5,000 employees has a problem with five employees, it’s not that big a deal, but when a five-employee company has a problem with two employees, it can be such a big and costly problem as to cost the company its China business. To be a well-protected employer in China, you need a well-written China employment contract and a China-centric set of Rules and Regulations, no matter your company size.

China’s employment laws are strict and protective of employees at all companies, especially those that are foreign-owned. If you as an employer fail to follow all mandatory employment laws, your employee will pursue you regardless of your size. Our China employment lawyers constantly get questions from China employers after they have been reported and/or sued by an employee China employee — mostly Chinese but increasingly non-Chinese as well.

The below is an amalgamation of the sorts of emails we frequently receive:

I cannot believe that I just got served with a lawsuit by one of my former Chinese employees. We are a small business and we pay all our taxes and we have always treated all of our employees right, including this one. We paid her really well and we were never late with her wages and we even gave her extra vacation days. We also paid all of her mandatory employee benefits and a few optional ones as well. We always did our best with her. And then she quit, completely voluntarily, and yet she is now suing and claiming we owe her double her monthly wages for not having a written employment contract with her? As you can see, her demand is totally unreasonable.

We then have to explain that with no written employment contract the employer stands virtually no chance in this arbitration.

It is not uncommon for foreign employers in China to state that they have done or are “doing their best” with respect to treating their employees well and following China’s complicated (and localized) employment laws. The problem is that neither the Chinese government nor its courts nor arbitral bodies care how hard you try. Your other law-abiding actions are not a mitigating factor in determining the penalty you will need to pay for having failed to enter into a written contract with your employees or for whatever other violation you may have committed.

The burden is on you as the employer to ensure you have a proper written employment contract fully executed by the parties. The best practice is to have your new employee sit down and sign a hard copy of the employment contract on her first day and you then retain an original copy of the fully executed contract for your records.

Consider this hypothetical. Employer asks Employee to sign a hard copy of the employment contract during the on-boarding process. Employee says: I will need some time to review this and I will take it home to read and I will return a signed copy. Employer says okay, but the Employee never returns a signed copy. Employer never makes an effort to “track down” that contract. Employee sues months or years later seeking a penalty from the employer for failing to use a written employment contract. Under this scenario, the Employer will be liable to Employee for failing to execute a written employment contract. If this sort of scenario sounds unlikely to you, let me just tell you that nearly every time we audit a company’s employment situation we find some percentage of employees working without signed contracts.

Now same facts as above, but Employee returns a signed copy with a fake signature. What will happen? Based on real cases with similar facts, Employer will probably be held liable for an employer penalty because there is no written employment contract bearing Employee’s actual signature, unless Employer has convincing evidence Employee faked the signature to “cheat the system” (which is a high evidentiary bar to meet).

If you are not sure you have current written employment contracts for all your employees, now would be a good time to check on this and fix it.

China Employment Law Female EmployeesAs today is International Women’s Day, this would be a good time for a quick overview on China employment laws that directly relate to female employees. Since there are so many national and regional and even local laws and regulations regarding female employees in China, this post necessarily seeks only to hit the high notes.

First, do not forget to give your female employees half a day off as International Women’s Day is their holiday (or follow the applicable holiday policy in your employer rules and regulations if it’s more generous than the law)!

Second, let me emphasize that female workers are always a big issue in China (not just today), primarily because they are accorded many additional special protections under China law. If you have been following my posts here or if you have a copy of my book (The China Employment Law Guide), you probably already know that employees who are pregnant, nursing or on maternity leave receive special protections exceeding those in many other countries. However, it is important to also note that these are not the only protected subgroups of female employees; they are simply the most often mentioned because the issues relating to them are the most common and because it is on these issues that foreign employers so often find themselves in trouble. For example, China’s laws also provide special protections for female employees during their menstrual periods. Many localities in China require employers provide a short (usually 1 to 2 days) paid leave to employees suffering from serious menstrual issues or to those with very heavy flows during their periods, so long as the employee provides a doctor’s note proving her condition.

Terminating a China employee is generally very difficult because China is not an employment-at-will jurisdiction and terminating a female employee is often even more difficult, especially if the female employee has a special status such as pregnancy. Subject to limited exceptions, employers in China are prohibited from unilaterally terminating an employee who is pregnant, nursing or on maternity leave. One common myth is that female employees in such special status can never be fired. This is wrong as these employees may be unilaterally terminated without severance for the employee’s failure to satisfy the employer’s conditions of employment during a probation period or if based on employee misconduct or wrongdoing. Alternatively, such an employee may be terminated if the employer and the employee agree to mutually terminate the employment relationship. See Terminating a China Employee: Why Mutual Termination is so Often the Key.

I will next month be putting on a webcast on April 18 on Employment Law for Female Workers in China. Do not miss it!

China WFOE Formation
China WFOE Formation. It’s complicated.

Yesterday, in the first part of this two-part series, I discussed how China is requiring foreign companies reveal all layers of WFOE ownership in the WFOE formation stage, I talked about how just as so many foreign companies are realizing the importance/necessity of forming a China WFOE, China has made it nearly impossible to form a WFOE without a full list of its owners. I first wrote about this issue in China’s New Foreign Investment Law: The “Actually Controlling Person” Requirement is Going to be Tough, but it is now at the point where the China lawyers at my firm are very clear with our clients who seek to retain us to help them form a China WFOE: you either reveal pretty much all owners of the WFOE-to-be (through the various layers of ownership) or your chances of getting a WFOE are not good. Clients unwilling or unable to make the required ownership disclosure in the exact form required by the PRC government authorities cannot proceed. There are no exceptions to the rule.

As noted in my earlier post, this is a threshold issue and this issue must be resolved before it makes sense to incur the time and expense required for aWFOE formation application.

China’s intent with this new [ownership disclosure] system is clear. The PRC government will no longer allow the use of special purpose vehicles and related entity structures to hide the actual ownership of the investors in PRC foreign-invested enterprises. And any attempt by a foreign investor to invoke a foreign law that allows secrecy with respect to ownership will [almost surely] be ignored. MOFCOM has plans to carefully audit all FIEs and that audit will include carefully reviewing their ownership structures. More important, however, is that a response that does not list out owners will simply not be accepted by the automated system. A response is therefore forced. A false response is a violation of law that can result in penalties and other legal/administrative action by the PRC government and its agencies.

Consider a typical private equity fund/venture capital type of ownership structure. The investor in the WFOE is Operating Company A. The owner of Operating Company A is a Holding Company B. Holding Company B is in turn owned by three private equity funds: Equity Funds C, D and E. The largest of the funds is owned by Equity Fund Z. As you can see, there are four layers of ownership.
For the MOFCOM information report, it is certain we will be required to disclose the following:
  • Operating Company A as the investor. This will require disclosing the officers and directors of Operating Company A.
  • Holding Company B is a 100% shareholder of Operating Company A. This will require we disclose Holding Company B, together with its officers and directors. We usually argue that Holding Company B is a “private equity fund”, and for that reason, we should not be required to disclose the shareholders of Holding Company B. Some MOFCOM offices will accept this argument. Some will not. Even if the local MOFCOM accepts, the higher level MOFCOM that does the later audit may not accept and then require all shareholders of Holding Company B be disclosed.
  • The local MOFCOM office may require disclosing the three shareholders of Holding Company B. If MOFCOM makes this demand, it will also require disclosing the directors and officers of Holding Company B. For the past several months, most MOFCOM offices have required this level of disclosure and foreign investors should plan on this disclosure being required.

The big question is whether MOFCOM will require moving up the chain to mandate disclosing the shareholders of the three shareholders in Holding Company B (Equity Funds C, D and E).  We have in the last few months been asked by various MOFCOMs for this level of disclosure, but we have so far been able to convince them that this should not be necessary. In one instance, we provided MOFCOM with an organization chart showing nearly 75 owners of an LLC (including many private equity funds) but ended up convincing it not to require our client disclose the names of these nearly 75 owners, as originally requested. When MOFCOM requests/requires this sort of disclosure, we normally argue that the C, D and E entities are “private equity funds” and disclosure of their ownership should not be required for the same reasons public company investors are not required to disclose their shareholders. Several local MOFCOM offices have recently tentatively accepted this argument, but this decision is not binding and the higher level of MOFCOM could demand more disclosure, either as part of the initial WFOE formation process or later as a result of their audit.

China has rejected shareholder secrecy and its requirement of full shareholder disclosure imposed on foreign investors is simply the consistent application of PRC law to all legal persons. The shareholder disclosure requirement is contrary to European and North American legal principles and on that basis many shareholders will refuse to consent to disclosure. However, under PRC law, there is no exemption. Moreover, as noted in Part One of this series, PRC local governments and MOFCOM offices are authorized to require even more sensitive private documents, such as the shareholders’ tax returns and tax returns of the WFOE’s foreign employees.
Bottom Line: If you are unwilling or even legally unable to comply with China’s ownership disclosure requirements you cannot proceed with a China WFOE formation. It is that simple and resistance is futile.